Integration of the Nordic electricity grids : incentives, cost sharing and regional perspective in transmission investments

Abstract: The overall purpose of this thesis is to study how the development of the electricity transmission grids in the Nordic countries can be given a stronger international perspective. This is a relevant issue for the further development of the regional Nordic electricity market. The thesis consists of an introductory chapter and two self-contained papers.Paper I analyses how an international cost sharing agreement for transmission analyses how an international cost sharing agreement for transmission investments could be designed to improve the regional perspective in grid development. The study is focused on how different agreements may affect the investment decisions made by TSOs for grid expansions where several countries are involved. This type of expansion has become a problem in grid development because although it is beneficial for several countries, it might still not be realised due to lack of a formalised practice for sharing the investment cost. The basis for cost sharing will be a cost-benefit analysis of the regional effects that a given expansion has. To model how a cost sharing agreement can be applied to this situation, two stages are defined. First a political stage where a cost sharing agreement is assumed to be formed among the countries in a region, followed by a TSO stage where decisions on specific expansions are made. The analysis is focused on the TSOs' decisions in the second stage. Cooperative game theory (CGT) is used to predict under which agreements that an investment coalition is formed. The cost sharing agreements evaluated consist of combinations of a contribution principle, a compensation principle (to account for negative spill-overs) and an allocation rule. The results show that the design of the agreement will affect the decision to invest or not. Two alternative rules are identified as good choices for providing incentives to invest; the nucleolus and proportional rules. Regarding the compensation principles it is concluded that full compensation should not be used.Paper II develops an incentive regulation method that can be used to provide TSOs develops an incentive regulation method that can be used to provide TSOs with economic incentives to focus on electricity market integration. A benchmark model is constructed to assess the performance of TSOs in facilitating cross-border trade. The model is based on the output-oriented technical efficiency of the TSOs, which is linked to market integration by defining an output measure for TSOs that includes the market expanding effects of trade. The output measure is the sum of national electricity consumption including imports plus exports of electricity. It is argued that TSOs can increase this output by expanding the trade capacities with neighbouring countries. The benchmark model is based on a stochastic production frontier defined by a translog output distance function with two outputs and three inputs. The frontier is empirically estimated by a fixed effects model using a panel data set of six TSOs. The included TSOs are the four Nordic and those of Belgium and the Netherlands (BL-NL). The estimated efficiency scores are in the range 61-100 percent, with the Nordic TSOs showing higher scores relative BL-NL. This can be explained by a lower level of electricity trade in the BL-NL region compared to the Nordic region. The use of the efficiency scores in a regulatory incentive scheme is demonstrated. The scheme is based on a reward/penalty mechanism that uses the efficiency scores to evaluate a TSO's development between two periods in relation to a target efficiency level. The results of this study show that the suggested regulation method could be used as a means to evaluate and set targets for the TSO's task of facilitating market integration.